Why Money Velocity Can Make or Break Your Wealth
Welcome to the 139th episode of the Alternative Investing Podcast!
In today’s episode, I’ll discuss the definition of money velocity and how you can use its power to reach your financial goals no matter where you’re at in your wealth-building journey.
- Defining Velocity of Money and How to Use It
- The Tension Between Velocity vs Risk
- How to Apply Velocity in the Three Stages of Wealth Building
- Story of Someone Who Misused Velocity of Money
- The Relationship Between High Income and Velocity
- Key Takeaways
If you’re an entrepreneur or an investor who wants to leverage money velocity to get ahead of the curve regardless of market conditions, then make sure to listen to this episode!
02:05 Defining Velocity of Money and How to Use It
06:18 The Tension Between Velocity vs Risk
07:52 How to Apply Velocity in the Three Stages of Wealth Building
13:04 Story of Someone Who Misused Velocity of Money
15:13 The Relationship Between High Income and Velocity
18:37 Key Takeaways
In today’s topic, let’s talk about the velocity of money and why it needs extra care in today’s environment.
I discussed this before and want to bring it up again because it’s more relevant now than when the economy was doing well.
If you’re going to ask me, my thesis is that investors who use the concept of velocity of money consistently and carefully will see much better results.
Why? Because the velocity of money is what drives wealth creation.
The metaphor I like to use is that of owning a car. If you park it in your driveway and never drive it, you’re not using it for what it’s meant for, which is to get around.
However, driving a car too fast or maintaining a high speed is dangerous, especially if you don’t pay attention to the road and the weather. Driving too fast can also cause disasters, especially in dangerous conditions like mountains, storms, lightning, and thunder.Read More
Defining Velocity of Money and How You Can Use It
Keeping this in mind, let’s talk about the velocity of money and how to use it.
Since we all have a general understanding of what velocity means, the velocity of money simply refers to the speed or movement of money. The velocity of money is an economic term used to show how well an economy is doing. It shows how often one dollar is used and passed from person to person.
A high velocity means that people are spending and using money, indicating a good economy and market.
The second part is how the velocity of money affects businesses.
Many people think a business’s job is to sell products, but their real goal is to sell their goods or services quickly, so they don’t have unsold items on shelves. Businesses want to make money fast, and that means speeding up the velocity of their money and profits.
In the banking industry, the velocity of money is very important to how they do business because this is why they can earn a lot of money.
Banks and big institutions tell people to save their money with them for safekeeping.
But, they do the opposite and lend the saved money to others.
People often think that banks make money by lending out the saved money and getting interest, but it’s much more complex. They try to lend the saved money to as many people as possible, and in some cases, one dollar might be lent to 9 different people simultaneously.
This means they can earn nine times the interest on that single dollar, and when you multiply that by all the dollars in the bank, you start to see why banks never lose money.
From an investor’s point of view, the goal is to make their money work for them by using it multiple times.
Sometimes this is easy, and sometimes difficult, but making your money move and finding multiple uses for it helps create those benefits and reduces the risk of losses from inflation and market changes.
The bottom line is that, as an investor, the velocity of money comes from two things: your mindset and the actions you take.
These two things work together to help you make the most of your money and wealth.
So, the velocity of money is not just about moving money aimlessly. It’s about considering the potential consequences of moving money from one place to another and making strategic decisions.
I’m not talking about buying and selling assets but about quickly putting new money to use instead of just letting it sit there, which means finding ways to access profits from assets without selling them.
The velocity of money can be applied in various ways in investing, but it’s important to understand which strategies align with your goals and risk tolerance.
The Tension Between Velocity vs Risk
This brings us to a topic I haven’t talked about yet: the tension between velocity and risk.
Now, people who don’t apply a lot of velocity often end up with less wealth over time. This can happen for various reasons, such as fear, lack of information, or indecision, which can result in a reduced level of wealth compared to their potential.
The other extreme is people who take risks and invest a lot often.
Entrepreneurs are a good example, as they tend to make a lot of money and reinvest it all instead of taking a break, which can be dangerous. Richard Branson, the author of the book “Losing My Virginity,” is known for taking risks with his money by investing all his profits into new projects.
Over time and with experience, he may have changed his approach, but he’s still known for being daring with his investments.
How to Apply Velocity in the Three Stages of Wealth Building
Please remember that there are three stages to building wealth, and it’s important to understand them when deciding how to use velocity.
The first stage in building wealth is to increase your capital, which means multiplying and leveraging your money to grow your net worth as quickly as possible. This may involve using leverage to turn $1 into more money. Doing so gives you the resources to make decisions about your next steps.
The best example is investing in properties and holding onto them to see their value increase over time instead of just keeping the money in a savings account.
The second stage in building wealth is to use the capital you have to generate income.
Most investments, except for alternative, don’t provide a high yield. So, the goal is to take your capital and find ways to increase the income it generates, even if it’s just a small amount.
The third stage of wealth building involves creating a reliable income stream that lasts forever.
This is a continuation of the first two stages, which were about increasing capital and income. If you want to learn more about these three stages, listen to my other podcast episodes, where I discuss the topic in more detail.
As we talked about earlier, Richard Branson is an example of a person who applied high velocity to build his wealth.
In his early years, he focused on building businesses, and wealth was a secondary goal. He was willing to take big risks with his money to reach his goals, and he loved the challenge of building businesses, which is why he applied high velocity to his wealth-building journey.
I understand that young investors often want to grow their wealth quickly, so they may be willing to take bigger risks. But as you get older and move through wealth-building stages, the focus may shift from growing your money to preserving it and getting a steady, sustainable return.
The amount of risk they take, or the velocity you apply, will depend on where you are on their wealth journey.
For example, many clients I work with have already made a good amount of money and now want to invest in assets that provide a higher income. They’re not as interested in maximising risk and growth, and like me, they want to focus instead on preserving their wealth.
When I first started investing, I was really interested in the idea of velocity.
And I was fortunate to grow up when, as an investor, the most important thing was if you could afford the cash flow of an investment property and have the money for the down payment, regardless of your income.
This is why many investors from my generation were able to build large property portfolios.
But things are different now, and this approach may not work in the current market.
Borrowing money to buy properties as a starting point can be a good idea. But if the banking sector starts lending money easily again, it’s not a good idea to keep buying properties and refinancing them when they increase in value.
This strategy involves having a very small amount of equity in each property and is extremely risky.
Story of Someone Who Misused Velocity of Money
Let me tell you a story about a fellow I met when I started studying more strategies around wealth building.
During a class with eight people, I shared about my own loss, and this person also shared a similar experience. He bought a property, waited for its value to go up, refinanced it, and repeated this process many times.
He also did this with small-scale developments. Over time, he had a large property portfolio worth $15 million. Unfortunately, one of the banks became worried about the economy and asked him to add more money to a loan, but he didn’t have the means to do it.
This led to a chain of events, causing him to lose all his properties.
The financial loss put a lot of stress on his relationship and household, and he eventually separated from his wife. The man understood the idea of velocity in building wealth but made mistakes in using it and misjudged the economy.
The lesson is that blindly investing and increasing velocity without paying attention to the environment is not a good idea. So that’s the story of someone who understood the idea of velocity in building wealth but made mistakes in using it and misjudged the economy.
What’s the lesson we can learn from here?
Blindly investing and increasing velocity without paying attention to the environment is not a good idea.
The Relationship Between High Income and Velocity
The other thing I want to revisit is the idea of high income and its relationship to velocity.
In many situations, I’ve noticed that sometimes people who make a lot of money don’t apply velocity as effectively as they could. They’re thinking, “I’ll do it tomorrow”, or “I have a financial planner who takes care of it for me.
Many people think you must be rich if you make a lot of money.
They see fancy things like big houses, nice cars, and expensive vacations and assume that they mean you’re wealthy.
But, after talking to many people about wealth and building wealth, I’ve learned that this isn’t true.
Having a high income is great because it means you can turn more of that income into wealth faster.
The problem is that when you make a lot of money, it can be tempting to act like you have all the time in the world and spend your money on a luxurious lifestyle. The idea of “velocity” means using your money quickly to build wealth because there’s only a limited amount of time.
But when people have a high income, they sometimes forget about this urgency and don’t build their wealth as quickly as possible.
So having a high income doesn’t guarantee you will properly apply velocity, and having a low income doesn’t mean you don’t have the right to consider velocity when you’re thinking about your wealth-building.
Some of you who know me well understand that in my own journey, I’ve always had a relatively mediocre income.
But I’ve always focused on using velocity to build wealth because I believe that this is more important than just having a high income.I’ve met many clients over the years, and one man, let’s call him Mo, had a very high income for many years.
He and his wife spent a lot of money on fancy vacations, a big house, and new cars and thought they had plenty of time to consider building wealth.
But despite having many opportunities to invest, he was very indecisive and worried about small things like transaction fees or solicitor charges. He always thought the market would get better in the future and never took the chance to invest.
Despite earning a high income for many years, this person (Mo) ended up with less wealth than expected.
He thought just earning a lot would lead to wealth, but it didn’t work out that way.
From this whole conversation, here are the key takeaways that I want you to remember:
Number one, we’re in an environment with high uncertainty. The economy may experience some difficulties, but how severe they could be is unclear. After all, we don’t know what the future holds.
In these uncertain times, thinking before you act is important instead of ignoring the situation or making rash decisions based on fear. Both of these reactions are not helpful, so a mindful approach to decision-making is the better choice.
The second important point to note is to change your thinking to be more independent if you want to be successful in investing over the next 5 to 10 years.
Many investors understand there are more opportunities to invest during tough economic times.
However, they often worry so much about a bad outcome that they don’t take action and miss out on these opportunities. To make the most of these situations, it’s important to have your finances and loans organised so you can act quickly.
Understanding and using the concept of velocity can help you stand out from other investors, but it’s not always easy. So if you want to understand this mental pivot to independent thinking, you need to recognise that when the market is filled with panic and fear, it’s important to get your finances in order.
This way, when opportunities arise, you’ll have the chance to take advantage of them.
The third and final piece of this concept of velocity is to increase your velocity of thinking. Part of this involves deciding whether to be an investor or a trader.
Some call themselves great investors because they have bought and sold real estate, shares, or even Bitcoin. However, as we move into this uncertain environment, we must remind ourselves that we are playing the long game.
Trading is okay, but it’s important to understand that it involves speculation.
In uncertain times, it’s better to focus on investments with a high chance of success or investments for the long term.
A good example is a small development project I’m currently working on.
Many problems have happened, causing some of the profits in the deal to decrease. But I’m not worried because I’m not trying to sell the assets quickly.
I’m keeping them for a long time and adding them to my collection of investments.
So even if I build at the market value, which might mean the profits will disappear after construction, it’s okay because the property is worth what it’s worth.
With this in mind, it’s important to change the way you think and consider the future consequences of your decisions before taking action. If you have a lot of debt, now is a good time to evaluate your portfolio, derisk where you can, and reorganise your assets to have less exposure to future volatility.
The goal is to put yourself in a position where you can apply a little velocity to get ahead of the curve as you recognise great opportunities.
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